Finding bargains on the sharemarket is extremely difficult. Companies that have strong balance sheets, deliver high returns on capital and have great prospects almost never sell cheap — and for good reason! As with most things in life, quality attracts a premium.
Similarly, shares that appear cheap usually are for a reason. If a business’ prospects have materially diminished, or weren’t as attractive as previously thought, then the market is right to discount its shares.
That being said, sometimes, though not often, the market’s pessimism may not be entirely justified. In some instances the cause for the negativity may not be rational, or perhaps the market is only focusing on the short term consequences without regard to the longer term potential.
Online travel booking website Wotif.com (ASX:WTF) provides an interesting case in point. With shares in the company down roughly 50% in the past year it is well worth asking whether the negativity is entirely reasonable.
A solid history
At present, Wotif.com is the dominant player in online accommodation in Australia. Since listing it has grown its sales and profits by approximately 18% per annum. The business has very low capital requirements, is virtually debt free, and has over $110 million of cash on hand. The company generates a return on shareholders’ equity of over 50% and distributes over 90% of its profits back to shareholders in the form of fully franked dividends.
Despite this impressive list of qualities, Wotif has seen a marked slowdown in its earnings growth of late. More accurately, there has been virtually no growth over the past few years.
An uncertain future
The concerns over Wotif all boil down to one thing: competition. Now of course, competition in itself is far from unusual — but in the case of Wotif the threat from competition is greater than it is for most.
Though there may be a degree of familiarity and trust in the Wotif.com service, there is nothing to stop Wotif’s customers from defecting to a competing service. Given that, for the most part, the same (or similar) rooms and flights can be booked through competing services, consumers tend to make their decision on price alone, as they do with all commodities. And with a number of large and well-funded new entrants fiercely competing over market share, Wotif.com could well see its customer base shift en masse if it isn’t careful.
Competing on price will prove difficult. As with all commodity style products, it is the lowest cost provider that wins, but even then ‘winning’ may not translate into growing profits. You may outlast your competition, but it is not much of a victory if you have had to seriously erode your profitability to do so. Wotif.com needs to find a way to compete other than by entering a futile race to the bottom.
In terms of convenience, or ease of use, all the major booking websites are fairly straightforward and all are becoming more user friendly with time. Wotif has a lot going for its web site, but establishing a durable competitive advantage on this front will prove extraordinarily difficult.
On the other hand…
Despite the challenges, Wotif.com does have several advantages. The business has excellent relationships with hoteliers who have come to trust the brand and certainly prefer the generally lower commissions it charges.
Similarly, as an early mover in the online booking space, the company has a large customer base and strong relationships with suppliers. Customer loyalty may indeed be fickle, but it is — or should be — easier to retain clients than to win them over.
Wotif has an exceptionally strong balance sheet and is rightly focused on ongoing development. There are some real opportunities in terms of expanding into other travel related areas which, if packaged effectively, could create a real point of difference.
The company also has the opportunity to expand into new geographies. Success here will be far from certain, but the advantage of an online business is that establishing a new presence is relatively cost effective.
Wotif.com operates in a highly competitive market, populated by large, well-funded and even, potentially, irrational competition. It is very difficult for the business to establish any durable competitive advantages, consumers can easily switch to competing services and any innovations are likely to be easily replicated by others.
While it could be argued that the trailing P/E and yield (10.0 and 9.5% respectively) allow for plenty of room for error, and although the business is in a good position to leverage off the advantages of incumbency, Wotif.com has everything to lose if it gets it wrong. And expectations are for profits to fall, increasing that P/E and reducing the yield.
At a certain price, a sufficient margin of safety will exist to justify the risks of investing in a company that operates in such a difficult space and is facing such significant challenges. Wotif.com needs to keep the competition at bay – something it’s done well so far, but is far from guaranteed. If it can do that, Wotif.com might be an interesting opportunity.
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